S Corporations Give Tax Benefits, And Now Can Have More Shareholders

SMALL BUSINESS - IDEA BANK

June 23, 1997

QUESTION: Congress changed the law regarding S corporation status. Why is the S corporation such a popular vehicle of business organization?

Both C and S corporations provide limited liability for the shareholders. However, each is taxed very differently. Earnings from C corporations are taxed to the corporation, and earnings from S corporations are ''passed through'' and taxed to the individual shareholders. The biggest advantage of an S corporation is that the earnings are generally only subject to a single level of tax. The earnings from the C corporation are taxed once when the income is earned and then again when the earnings are distributed (e.g. dividends). Ownership of an S corporation is restricted to certain types of shareholders. Recent legislation increased the maximum number of shareholders from 35 to 75. This change increases the potential of the S corporation to raise capital.

Bonnie Cappello, CPA,

tax manager,

Palmer and Bagwell CPA, P.A.

S corporations have some similarities to partnerships, and the S corporation provides limited liability to the shareholders. In general, neither pay federal income tax. Partners and shareholders separately account for their share of income, expenses, losses and credits. These items ''flow through'' to the individual partner or shareholder in the tax year the partnership or corporation ends, and these amounts are subsequently included on individual tax returns for that year. However, deductibility or losses are limited and need special calculations. Disallowed losses may be carried forward. The S corporation or partnership is still a tax reporting entity and must file an annual return. This is an area of increased tax complexity. It is recommended that anyone considering the advantages or disadvantages of either an S corporation or partnership consult with a tax and legal professional experienced in such matters.

Linda Smith,

Advanced Business Service

S corporations provide special benefits for the small business owner. However, whether an S or C corporation, loans for closely held or S corporations almost always require a personal guarantee by the financing source. This is because the liability exposure to the lending institution is greater when there are a small number of shareholders (typically a family), and the profitability and the ability to raise any additional capital to sustain the profitability of the business is dependent on a small number of shareholders. Therefore, the incorporation process, while providing distinct tax benefits, has no effect on the financing of the business. For more information, call the Internal Revenue Service at 1-800-829-3676 and request the 1120-S instruction, visit its Internet site at http://www.irs.ustreas.gov or contact the University of Central Florida Small Business Development Center at (407) 823-5554.